A trust is a legal fiduciary arrangement where the trustor provides the trustee with the right to hold the title of assets and properties for the benefit of the beneficiaries. A trustor is a person who establishes it, while a trustee is the individual in control with a legal obligation to administer the assets or property for the purpose specified. Each of the types have different characteristics and purposes as well.
When you talk about trust funds, you may be thinking that these are only for the super-wealthy. But it doesn’t matter if you come from a mountain of wealth, or if you just wish to provide an efficient way to manage your assets and pass them along to your children accordingly. Creating a trust will provide legal protection for your assets. This will allow assets to be distributed according to the wishes of the trustor. In addition, you to reducing time, additional paperwork, and possibly helping avoid potential estate or inheritance taxes.
Basic Types of Trust Funds
Now that we have a high-level understanding of what a trust is, we can start to dive into the basic types of trusts. From there we can explore the variations of these types.
A revocable trust designates beneficiaries who will receive distributions upon the death of the owner of the trust. A revocable trust can be changed, altered, or terminated entirely at the discretion of the trustor. Upon the death of the trustor, the assets are transferred to the beneficiaries. A main advantage of the revocable trust is that it is flexible during the lifetime of the trust, while also allowing the distribution of all assets from the estate.
With an irrevocable trust, the assets within it are not yours anymore, nor can you make changes to it without the consent of the beneficiaries. Once placed in the trust, the owner surrenders all legal ownership to all of the assets and properties. Once the trustor passes away, the trustee would manage the assets and distribute them to all beneficiaries.
A living trust is a tool that is used in estate planning in order for individuals to pass along assets and property without having to go through a probate process. Living trusts are managed by someone who has a fiduciary obligation to manage the account in the best interest of the beneficiaries. Any income earned on trust assets is reported as income tax for the settler. These funds do not offer any tax benefits.
Special Types of Trust Funds
Aside from the more general categories of trusts mentioned above, there are special types of trusts that you can establish within your estate planning.
Testamentary trusts are created by the will and ] begin when the person who created the will becomes deceased. At this point, assets and property are transferred to the decedent’s estate. This is an irrevocable trust since it comes into existence at the death of the trustor.
Some benefits of a testamentary trust are that it can protect assets or properties and can potentially reduce tax liabilities paid by the beneficiaries from the income from the inheritance. This can provide a higher level of control and flexibility over the asset distribution to all beneficiaries.
Bypass Trust (Credit Shelter Trust)
Often referred to as a “B” trust, bypass trusts are established by married couples to reduce estate taxes for their heirs. This type is irrevocable that transfers the specified assets directly from one spouse to the surviving spouse, as detailed in the agreement.
One of the key benefits of the bypass trust is that certain rights are maintained by the surviving spouse over the course of the rest of their lifetime. The assets may transfer to the spouse, however, the surviving spouse never really has control of the assets since the trust is managed by the trustee. Hence, this does not add to the surviving spouse’s estate, basically bypassing the taxes.
Generation Skipping Trust
A generation skipping trust is a type of trust that designates grandchildren, great-nephews, great-nieces, or anyone 37.5 years younger than you as the beneficiary, instead of your children. This type allows you to pass your assets on to your designated heir, allowing your children to avoid the estate taxes. The main benefit of this, besides avoiding the estate taxes, is that your children will still be able to access any income that the assets produce.
Qualified Personal Residence Trust (QPRT)
QPRT, which stands for “Qualified Personal Residence Trust” enables a person to transfer their personal residence into that trust. The trustor may live in their house for a number of years. Any interest that is retained reduces the current value of the asset (or gift to the trust) for gift tax purposes. All of the post-transfer appreciation on the house is removed from the estate.
Life Insurance Trust
Irrevocable Life Insurance Trust (ILIT) is a trust that you designate to hold a life insurance policy. How this works is that you designate the trust as your beneficiary on your life insurance policy, then when you die, the policy payout goes directly into the trust. The main advantage of an ILIT is that it allows you to avoid the estate taxes on the life insurance policy distributions.
Qualified Terminable Interest Property Trust (QTIP)
A Qualified Terminable Interest Property Trust (QTIP) gives the ability to provide for a surviving spouse, while also managing the trust’s assets once the second spouse dies. With a QTIP, a certain income is paid to the surviving spouse and the remaining balance of funds stays in the trust.
After the death of the second spouse, the beneficiaries are then paid out the remaining distributions as specified by the trustor. With this type of agreement, the estate taxes are not issued after the death of the first spouse but are issued when the surviving spouse passes away.
Separate Share Trust
Separate share trusts are more complex and include different share rule for separate beneficiaries A ‘separate share trust’ is a way to describe the separation of portions of the total from each other so that they are separate or “walled-off” from one another.
If you want to set up a trust without the beneficiaries having any knowledge of the trust, you should consider making a blind trust. The trustee, acting as a fiduciary or power of attorney, would have full authority over the assets and properties. A blind trust is typically created when a trustor doesn’t want the beneficiaries to know what specific assets are allocated and to avoid any potential conflicts of interest.
A spendthrift trust is a trust you would use if you have concerns about your heirs spending carelessly and wasting their inheritance upon your death. The spendthrift trust is irrevocable and is managed on a consistent basis by the trustee, from the time of its creation, until the time of the trustor’s death.
Many other trusts close down once the trustor dies and assets have been distributed, a Spendthrift trust remains open. The purpose of this type of trust is that it allows you to specify how and when the assets will be distributed to the beneficiaries, the idea behind this is to prevent the assets from being misused.
Some reasons you may think that a beneficiary may misuse funds:
- Generally not good with money
- May be in debt already, or susceptible to fall in debt easily
- Could have addiction issues that could lead to wasted money
A Marital trust often referred to as “A” trust, is established by one spouse for the benefit of the remaining spouse. It goes into effect when one of the spouses passes away. Assets that are in the trust, as well as any income that they generate, go to the surviving spouse. When the second spouse dies, the trust is passed on to the intended heirs. At this time they would be responsible for paying the estate taxes on any remaining assets.
A Totten trust is a bank account that you can add funds to, make withdrawals, or close the account at any time just like a normal bank account would. With a Totten trust, however, is that you name a beneficiary to receive assets when you die. This is also known as a “Payable Upon Death” account because the money goes to your beneficiary named on the account when you pass away.
Charitable trusts are irrevocable trusts that allow you to designate a charity as a beneficiary upon your death. There are two types, the charitable lead trust, and the charitable remainder trust.
The charitable lead type of trust allows you to provide a set amount that you would like to go to charity, while still being able to pass the remainder of your assets to your beneficiaries. The charitable remainder type of trust allows you to still have access to your assets for a period of time, with all leftover assets being transferred to the charity of your choice.
Special Needs Trust
A special needs trust allows you to financially provide for someone with special needs, whether it be a child, parent, or sibling, without compromising their ability to receive government aid.
The beneficiary would still be able to receive public assistance disability benefits from Medicare or Medicaid, Social Security, etc. The money in there allows the beneficiary to still be able to pay for day to daycare or any medical payments, while still remaining eligible for the government benefits.
Should You Start a Trust?
Establishing any of the types of trust funds is a personal finance decision worth considering. For starters, trusts make passing your assets and property to beneficiaries much easier. Trusts avoid the need for probate court, which only costs money and time. Another advantage is that your estate remains private. Probate court is public, and others could get a peek into how large that estate is – we believe some things are left in private, especially your finances.
Not sure where to start? Financial advisors can be great resources in defining what you may need, and where to start. For those looking to learn more about how to start a trust, check our free guide here.